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Reality check for rosy view of convergence

The affair is not over but investors’ passion for a new EU convergence story has cooled. They are beginning to price in the impact of delays to entry for leading candidates, the long run-in for others, and the unlikelihood of rapid single-currency status for any new members.

Central and eastern European sovereign bonds have become the darlings of emerging-market investors in the past few years. Investors found the 13 official candidates for EU entry particularly appealing since they offered the tempting option of reasonable yields combined with the prospect of credit rating upgrades and capital gains as these countries moved closer and closer to EU accession.

Investors made huge gains on convergence trades in the run-up to the European single currency in the mid-1990s, buying high-yielding bonds of countries such as Italy on the basis that political momentum would push it into the single currency. Now investors want to enjoy a second version of the great convergence-trade party.

After all, nowhere else in the emerging world could you guarantee that every credit in the region would be on the same conservative economic and political path in order to meet EU accession criteria. Or that 10 of these countries would have to meet these criteria at exactly the same time in order to qualify for big-bang entry in 2004. These were not credits being priced according to investor emotions. On the contrary, they were driven by logic.

That was the theory anyway.

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